Monday, January 30, 2012

The Rust Belt Came Back Strong in 2011; Midwest Manufacturing Is At the Forefront of the Recovery

The Chicago Federal Reserve reported today that its Midwest Manufacturing Index (CFMMI) increased 1.7% in December, to a seasonally adjusted level of 87.4 (2007 = 100). Here are some highlights of manufacturing activity in the 7th Federal Reserve district that covers Illinois, Indiana, Iowa, Michigan, and Wisconsin:

1. Manufacturing output in the Midwest region rose 8.4% from a year earlier in December, more than twice the 4% increase in national manufacturing output over the same period.

2. Regional machinery output in December was up 12.1% from its year-earlier level, compared to a 3.9% increase in machinery output at the national level.

3. Regional steel output was up 14.6% from its December 2010 level, compared to a 8.5% increase in national steel output over that period.

4. The Midwest’s automotive output was up 14.8% in December from its year-ago level, compared to a 9.8% gain in national automotive output.

MP: The manufacturing sector of the U.S. economy grew at 4% last year, or more than twice the 1.7% growth in overall GDP, so it's pretty clear that American manufacturing is at the forefront of the economic recovery as has been frequently reported here and elsewhere, as weak and sub-par as the overall recovery might be. Without that strong rebound and growth in manufacturing activity last year, the current recovery would be much weaker. And given the strength of Midwest manufacturing activity compared to output at the national level as reported today by the Chicago Fed, I think we can say that it's "Midwest manufacturing" that's at the forefront of the economic recovery. The Rust Belt is coming back.

"Many big U.S.-based industrial companies are benefiting from "pent-up demand for motor vehicles, the need to upgrade business equipment and more investment in energy and mineral exploration," said Daniel Meckstroth, chief economist at the Manufacturers Alliance for Productivity and Innovation."

Updates: See previous posts on the Rust-Belt recovery here, here, and here.

In 1972, cars were worn out in five years or about 100,000 miles. I bought my first "new" car in 1971 that had 75,000 miles on it, and everyone said it was already time to get a new one!

My newest car now is 7 years old and I plan on 200,000 miles before I buy another one.

1972 is not 2012; our peaks are likely behind us. Everyone I know drives their cars longer than they used to either because they want to or they can (but, to bolster your argument, there are a lot more multi-car families today, too).

if this weak dollar is so helpful to americans, then why is it that imports grew nearly 3X what exports did last year in absolute dollars and prices of imports were up around 13%.

does that make us better off?

you are mistaking a sop to a few special interests that creates a net loss for the country as a whole for prosperity.

you also, as ever, do not have the slightest idea what you are talking about about japan. their economy did best during periods of a strong yen.

their problem was not their currency, it was demographics combines with perpetual government "stimulus" that was really just massive, systemic malinvestment that took $1 and bought 20 cents worth of goods for it (useless airports, roads, and bridges were a favorite).

such massive misallocation of capital to drive "growth" by alleged boosting I destroys an economy while letting cargo cultists like you claim growth.

the quality of I matters. borrowing money to build a new semiconductor plant is very different than doing so to build the world's biggest mud pie.

that seems like a bit of a stretch as an argument given that 2006-7 were pretty much all time highs in light vehicle sales. population has a huge effect on the number of cars sold too. the US is what, 50% bigger than 1972?

that's a lot of folks buying cars.

they didn't suddenly start lasting longer in 2008. the sudden drop in sales was not driven by durability increases. that would be the sort of thing that would be a long, gradual trend, not a sudden sharp one.

Maybe it is a stretch, but I have a feeling that 2008 changed a lot of people's minds about the difference between what they want and what they need in addition to the durability trend.

A lot of people are locked out of the credit market over letting their house go back to the lender or trying to live on credit cards while out of work. How many of those people do you suppose have any extra $20,000 lying around collecting dust?

The durability factor makes not buying a new vehicle financially possible by the repair bill being smaller than the replacement bill. So, we have those who can buy new not buying by choice and those who can't buy still aren't buying. I can see a long trend ahead of us driving our cars longer.

that trend has been going on for decades. the average age of the us fleet keeps going up. as i said, it may have made the drop in 2008 less damaging, but i do not think it was the cause.

i suspect that if the economy improves, car sales will bounce back.

that said, i think 2012 will be a year of muddle and 2013 has a real shot at being the year of another nasty crisis led by the euro coming apart, so i'm not terribly optimistic on cars getting back to 2006-7 levels in the near term.

they didn't suddenly start lasting longer in 2008. the sudden drop in sales was not driven by durability increases. that would be the sort of thing that would be a long, gradual trend, not a sudden sharp one.

The contraction hurt many families. One way to respond rationally was to let their vehicles last longer and to cut down on their driving. The trouble is that at some point vehicles start getting too expansive to repair and families will have to look to purchasing new vehicles. That is what they have done. But the pent up demand is not a sound basis for a recovery in domestic automobile production. For the industry to truly recover it will need a real and lasting improvement in economic activity. We are still not there yet.

BTW, Pep Boys going private at 24 percent premium to market. Private buyers willing to pay premium for public cos. May see "going private" rally this year on Wall Street. Looks like double-digit rally in place for DJIA in 2012.

YOUNGSTOWN, Ohio — A rare sight in hard-luck Youngstown, a new industrial plant has generated hope that a surge in oil and natural gas drilling across a multistate region might jump-start a revival in Rust Belt manufacturing.

they would have gone through BK just as they did and the recovery would likely be about the same, just with different owners.

in the long run, it would likely be better for them as now, after the creditors that should have been paid got gouged for the benefit of a politically connected union, no one is going to be anxious to lend them money in the future. why play against a stacked deck?

All current laws were followed for a 363 bankruptcy following precedent set years ago by Lionel. Unlike a straight bk, the creditors lose a lot of rights in a 363 bk because the viability of the company is the main objective. If you look it up, you will find most of the judges who made the Chrysler and GM rulings were appointed by Republican presidents. These are lifetime appointments, too. Not liking the rulings and the rulings being illegal are not the same thing.

Washington, DC – Today, the Obama Administration announced $8 billion in conditional loan commitments for the development of innovative, advanced vehicle technologies that will create thousands of green jobs while helping reduce the nation's dangerous dependence on foreign oil. The loan commitments announced today by the President include $5.9 billion for Ford Motor Company to transform factories across Illinois, Kentucky, Michigan, Missouri, and Ohio to produce 13 more fuel efficient models; $1.6 billion to Nissan North America, Inc. to retool their Smyrna, Tennessee factory to build advanced electric automobiles and to build an advanced battery manufacturing facility; and $465 million to Tesla Motors to manufacture electric drive trains and electric vehicles in California.

the auto BK was done as a negotiated deal, not a in a court nor with a judge.

the government used its massive coercive power to force creditors to take far less than they would have gotten in court and utterly disregarded the seniority structure in favor of the UAW.

it was a taking under duress.

you read of that law is totally inaccurate. the creditors have to agree to enter such a settlement in the first place and they did not do so freely.

they threatened funds that owned the debt with audits ever year for them and for every limited partner they had.

i know this because i know some of the people who were threatened personally.

they faced a stark choice:

give in and lose money so the UAW could get paid or be hounded out of business.

we have had this discussion a number of times before and you cannot hide behind the "it was a legal deal" augment.

it was done under duress and was a blatant and deliberate misuse of federal power.

you will doubtless respond, as ever, with the "might makes right" philosophy that you always try to hide behind, but such a philosophy is as anathema to a system of rights and individual liberty as it is repugnant.

the job of government is to protect the rights of citizens, not subvert them selectively for political gain.

363 is not intended for use with entire companies. it's intended to liquidate a few assets. it's actually illegal for a 363 to serve functionally as a reorg.

"Moreover, in a typical bankruptcy case in which a secured creditor is not paid in full, he is entitled to a “deficiency claim” — the terms of which keep the bankrupt company liable for a portion of the unpaid debt. In both the Chrysler and GM bankruptcies, however, no deficiency claims were awarded to the wronged creditors. Were bankruptcy experts to comb through American history, they would be hard-pressed to identify any bankruptcy case with similar terms.

To make matters worse, both bankruptcies were orchestrated as so-called “section 363″ sales. This meant that essentially all the assets of “old Chrysler” were sold to “new Chrysler” (and “old GM” to “new GM”), and were pushed through in a rush. These sales violated the longstanding bankruptcy principle that an asset sale should not be functionally equivalent to a plan of re-organization for an entire company — what bankruptcy lawyers call a “sub rosa plan.” The reason is that the re-organization process offers all creditors the right to vote on the proposed plan as well as a chance to offer competing re-organization plans, while an asset sale can be carried out without such a vote.

In the cases of GM and Chrysler, however, the government essentially pushed through a re-organization disguised as a sale, and so denied the creditors their rights. As the University of Pennsylvania’s David Skeel observed last year, “selling” an entire company of GM or Chrysler’s size and complexity in this manner was unprecedented. Even on a smaller scale, it would have been highly irregular: While rush bankruptcy sales of much smaller companies were once common, the bankruptcy laws were overhauled in 1978 precisely to eliminate this practice."

I agree the bankruptcy was unprecedented and politics played a huge role. Our country is designed for politics to have a much larger role than is probably good for us as individuals. I don’t see that changing in my lifetime, so my choice seems to be to leave the U.S. or stay here and deal with the system we have. I think I will stay here and figure out how to play the game.

I think people are underestimating the impact a liquidation of GM would have caused. Unless we ignore the brilliant minds running Ford, Ford would have been lost, too. Additionally, the "do nothing" alternative was estimated at three times the cost of what they decided to do. I don't think there was a will to take the short-term pain for what might have been a long-term gain.

A lot of people lost money, but I hope no one ignored the first rule of investing: diversification. Following that rule would have held their losses to less than 5% of their portfolios, and the courts decided, rightly or wrongly, they could absorb the small loss much better than the workers could absorb a bigger loss. I did not follow that rule and lost a lot of money from owning GM stock in addition to around $15,000 in compensation a year from the adjusted contract.

As a GM retiree exactly 30 days from now, I hope GM and the UAW can get it right this time!

A lot of people lost money, but I hope no one ignored the first rule of investing: diversification. Following that rule would have held their losses to less than 5% of their portfolios, and the courts decided, rightly or wrongly, they could absorb the small loss much better than the workers could absorb a bigger loss. I did not follow that rule and lost a lot of money from owning GM stock in addition to around $15,000 in compensation a year from the adjusted contract.

Diversification produces mediocrity at best and terrible results at worst. No Japanese investor who diversified did well in the past two decades. No American who diversified and hung on since 2000 has managed to beat inflation. The trick is to buy asset classes that are cheap and to hang on to them until they become expensive.

not advocating it but pointing out that it's been done many times - even during Ronald Reagan's time in office.

The list is incomplete. There is no mention of the bank bailout by Bush I and the Fed or of the second bank bailout when Clinton backed Mexico because Citi, BoA and other American financial institutions were too exposed to Mexican bonds. But it does show that both parties favour bailouts to letting the markets work.

Which is why both parties should be rejected at the polls if there is any desire to see meaningful change.

I find the people who look for tricks of investing get tricked. I've been a hard worker, huge saver, mostly buy-and-hold all my life, and I beat inflation almost every year (and ALL 10- and 20-year periods). I make more money yearly now from my investments than I do from my income as safely as I can (except 2001 and 2008!). Looking for market timing or tricks will get you burnt.

You can easily diversify in a class of investments without owning more than 5% of your portfolio in GM stock or bonds. I screwed up and let that get up to 8%, but that will not happen again.

We will have either a Republican or Democratic president for the rest of my life, so all of my plans can be set to that constant. I will save any fleeting fantasy otherwise for the movies.

People told me I was nuts for saying GM would declare bankruptcy within 10 years back in 1998 and going back to school along with another job. They still say I am nuts, but not about the bankruptcy anymore!

You can easily diversify in a class of investments without owning more than 5% of your portfolio in GM stock or bonds. I screwed up and let that get up to 8%, but that will not happen again.

It did not matter if you owned GM, Citi, GS, or any of the 'cheap' housing stocks. When the contraction came all of them took a huge hit. Diversification gives you a better exposure to what the economy is doing. While that may be fine when it is doing well it is poison when there is a contraction.

I don't worry about contractions with my 5-, 10-, and 20-year financial plans. I short-term ladder my 0-5 year cash-flow needs with "safer" investments and current income/pension earnings.

The market goes up, and the market goes down. It always has, and I assume it always will. If it does not follow this historical pattern in the next ten-year period, I will adjust my plans accordingly. I do worry about 100% losses because you cannot recover from those regardless of how long you hold them.

Larry G.,

Save and save and wait and wait. Invest in yourself. Think long-term. Breathe. You will be fine. Don't quit saving or buy high and sell low.

Pension funds are getting dinged because they are using unrealistic disount rates of 9% or more. On top of that, they are not timely funding their shortages. I use 6%.

Remember: Your long-term investments are throwing off unrealized profits and losses. They are not real until you sell.

Keep watch, but don't sweat if the line on the chart goes down instead of up for a while. That's just how it works. And don't count your house as an investment because it is just a place to crash, and you always have to have that.

GM was rated junk way, way long before the bankruptcy. Long enough for prudent investors to profitably get out. The people still holding GM bonds in 2008 were either ignorant investors or gamblers hoping to make a killing: They were not investors.

"Our country is designed for politics to have a much larger role than is probably good for us as individuals."

i could not disagree with this more vehemently.

our country was designed to give the rights of the individual primacy and keep politics to a minimum. it was designed with a TINY federal government with very limited powers that were explicitly delineated.

read the constitution. it is VERY clear on that point.

and that's how it worked for 150 years.

in the 20's the federal budget was still <2% of gdp.

then, between the double whammy of hoover and particularly fdr (a true fascist and fan of mussolini) we moved to big, interventionist, redistributionist government.

this was not design, it was contrary to design and a massive, unconstitutional usurpation of power. but, it was a "crisis" so everyone went along and ignored that fact.

this is why crises are so dangerous. we throw our principles under the bus when some politician claims "pragmatism" or "dire need" and takes our rights "for the common good". it's precisely what we have seen in this last crisis as well.

the estimates for the "do nothing" side came from UAW sponsored entities and politicians barracking for their own benefit.

i have not seen any that looked realistic. what would have happened?

plants would have closed, sure, but they did that anyway. gm closed what, 1/3 of its plants?

car sales plummeted anyway.

using chap 11 and DIP financing would have minimized disruption. it also would have left the new entities with access to capital markets later. you think anyone is going to loan money to a UAW run enterprise after what happened to the last set of senior secured creditors (especially at C) without charging a hideous premium?

this was an excellent change to rework a hidebound and industry that has serially failed. it's not like this was the first bailout. it won't be the last either. we'll see GM with its hand out again in 15 years. i'm not even clear why C should exist at all.

this is just another case of propping up failed businesses for political reasons. unlike past efforts, they did it not just at taxpayer expense (which in and of itself is not supported anywhere in the constitution) but by violating settled BK law and practice and taking money from creditors to pay the UAW.

this focused taking is the literal equivalent of a mugging. that is the act of a fascist state, not one based on rights and liberty. you'd expect it from chavez, not the POTUS.

this, in many ways, is the worst effect of the whole thing. such outrages are always easier to commit the second time as you can point to the first and claim precedent.

that's how we wound up with a federal government exercising so much extra constitutional power in the first place.

"GM was rated junk way, way long before the bankruptcy. Long enough for prudent investors to profitably get out. The people still holding GM bonds in 2008 were either ignorant investors or gamblers hoping to make a killing: They were not investors."

nonsense walt.

that's just pure fiction.

many were sanguine about the bonds because they were senior in the capital structure. loans made in recent years were senior AND secured.

such debt gets precedence in a liquidation.

it was the deliberate violation of settled bankruptcy law and practice that hung them out to dry.

your attempts to cast them as riverboat gamblers who should have known is just weak rationalization. it's not that they did not understand the game or the risks, it's that the government changed the rules.

it's the equivalent of having 4 aces and having the dealer tell you that a pair of 4's beats them.

as such had NEVER before happened and the US has (or had up until that point) the best understood and delineated and therefore most predictable BK system in the world, saying "well, they should have expected the government to overturn decades upon decades of settled law" is just absurd.

it is precisely this disruption of and damage to such a longstanding and successful system the comprises so much of the damage done here.

i would certainly not look at lending money to any company with a powerful union the same way.

predictability of outcome under law is absolutely essential to investment and thereby economic prosperity. one need take only a cursory look at the impact of capricious fascist systems and how rapidly they derail and destroy growth to see how true this is.

venezeula and columbia over the last 10 years provide outstanding counter examples of this. vz went from prosperous to ruined and columbia the opposite precisely by pursuing opposite courses in this regard.

many foreign car producers do have the same problems and have gone out of business.

the british industry largely failed. opel, fiat, saab, and many others failed. even storied firms like lamborghini needed to be taken out. mostly they were bought by successful firms.

that's how it is supposed to work. those who know how to make good use of assets buy up the assets of those who use them badly. this makes the whole industry stronger.

protected producers (trabi, etc) make crappy product and lose money. they never get better.

failure is a key and integral part of capitalism (or any kind of evolution). prop up losers repeatedly (like GM and C) and they are freed from natural selection and wind up unevolved cro magnons in an age of homo sapiens. is it really any surprise that they cannot keep up?

The small federal government idea kind of went out the window with the Civil War. What we have now is a huge out-of-control social, economic, and political system with the federal politicians in charge. The Electoral College will guarantee it stays that way by giving us a choice of two political parties as a leader for President that are not really much different.

Any viable plan has to operate within its constraints for success, and those political parties are ours. You might be young enough to rebel and change the future. I was that way once. However, I am at the point of figuring out how to make what we have now work comfortably for my remaining years. You seem to have a brilliant mind, and I wish you and your ideals good luck in the future.

Larry G.,

Foreign car makers have historically operated with a much smaller market share. U.S. car makers could not handle the drop in market share because of legacy and over-capacity costs. Put simply, the head became too heavy for the neck to hold up.

morganovich,

You seem to think an unprecedented situation like a GM bankruptcy was going to follow precedent. There is nothing to base that assumption on. I will keep my junk bonds in a diversified high-yield bond fund for just that reason.

"The small federal government idea kind of went out the window with the Civil War."

nonsense. you are confusing the primacy of states rights with small government.

i agree that Lincoln did a great deal to harm states rights and erode the protections they had been deliberately afforded, but 70 years later the federal government under coolidge was still only 2% of gdp. it rarely interfered in private commerce (with perhaps the notable exception of eminent domain for railroads) and was not in the wealth redistribution nor social welfare business. that all came later. calling 2% of gdp "big government" seems a pretty severe stretch.

fwiw, i agree with you about the electoral college, and outdated and deeply harmful system.

i do not think one has to choose between notions of living according to one's ideals and taking care you one's own comforts and financial security. it saddens me to learn that you believe such is the case, though perhaps the view is different from an industry so mired in union power politics for the extraction of wealth from others.

to my mind, support of individual rights and the use of them to engage in consensual commerce is precisely how to become wealthy and secure.

i despise groups like noted VC keiener perkins who, having been massively successful due to such ideals now seek to rent seek by lobbying government and buying political favoritism thereby pulling up the drawbridge behind them and not letting anyone else have the benefit they did.

it's just horrific, blatant hypocrisy, worse even than divorcing the wife who paid your way through business school by working once you get rich and want a trophy on your arm.

i fear it is precisely your sort of thinking that makes this mess.

you acquiesce to the system and seek to turn political corruption/power/patronage to your advantage out of "pragmatism" despite your ethics.

in many ways, this resembles the classic game theory example of the "prisoners dilemma" whereby we get consistently sub optimal outcomes because the incentive to be the first to defect if you fear that others will is too great.

the likelihood of such a "low equilibrium" increased dramatically with the number of players in the system.

so long as government has the power it does, there is really no way to avoid such an outcome, thus the only way to win is to take the power away from government.

it worked for 150 years.

but once you let the genie out of the bottle, getting it back is is very difficult.

"You seem to think an unprecedented situation like a GM bankruptcy was going to follow precedent. There is nothing to base that assumption on. I will keep my junk bonds in a diversified high-yield bond fund for just that reason."

and just what was so "unprecedented" about GM?

nothing.

it was just big.

would you expect a murder trial to go differently and use different laws because you killed an unprecedented number of people? or stole an unprecedented number of cars? embezzled unprecedented money?

no.

the whole point of a predictable legal system is that such things are irrelevant. you have the same rights at trial if you stole $10k or $10 million. you should have the same rights as a creditor if you loans money to bob's bait shack or general motors.

anything else is capricious, arbitrary, and fascist.

further, let's face it, GM got into this position by getting bailed out last time. we'll see them again and the mess will be even bigger. they are the corporate equivalent of paris hilton, lurching from mess to mess, protected from the consequences by patronage, learning nothing except how to game the system next time.

under chap 11 you would have had DIP (debtor in possession) financing, continued operations, and probably about the same number of plant closures that actually occurred.

you act as thought it all would have shut down in one grinding screech and put everyone out of work, which is just not true.

there have been lots of big BK's, including whole industries (like airlines) that are critical to us commerce.

"I would expect a murder trial to go much differently if the President was assassinated than me. Ethically or morally I know that's wrong, but that is how it is."

actually, i think you have this the wrong way around. being tried for assassinating the president would be incredibly public and therefore subject to incredible scrutiny. as a result, the law would be followed assiduously and scrupulously. you would get the full extent of your rights.

you would be much more likely to get railroaded in some backwoods court.

"Just like me, you made your money in this corrupt system."

but never by taking advantage of that corruption nor encouraging it.

i made my money by holding to the principals of rights and free commerce and actively pursuing and promoting such to the benefit of myself and the society. i have helped put corrupt companies out of business and to make good ones grow. it hardly seems fair to equate that with corruption.

I don't know who is corrupt or not corrupt or even how to define corrupt. I buy or sell by looking at the data and doing a bit of research. I'm watching KMP this week. I imagine they have lobbyists in D.C. trying to get laws passed favorable to them. I guess that could be called corrupt. I don’t have a problem making money on them if they are successful , and I won’t spend any time worrying about it.

you could actually argue that GE is already paying a massive price for their strategy as it limits innovation and tends to lock them into a static incumbency strategy that will get them left behind in the medium term.

i guess what i am saying is that seeking political patronage winds up hurting you more than it helps and so i never see such companies as attractive investments.

they hide a lack of innovation and competitiveness behind a river of pork, but that ALWAYS catches up at some point and they guys who have been innovating and competing in the interim eat them alive given half a chance.

this is the fundamental problem for people who have full-time jobs that are not investment specialists.

Actually, it is a bigger problem for the full time traders. And the last time I looked the 'investment specialists' failed to see the precious metals bull market, the housing bubble, the NASDAQ bubble, or the problem with the financial sector. Most of the people that are shown on the financial media are little more than empty suits who make money by trading other people's money or selling lousy advice.

trying to save and not lose your money as an average "investor" is no longer an easy thing to do.

If you have the courage to stand alone and not be a prisoner of your emotions it is easier than ever to get rich. But if you do have the courage to stand alone and to ignore the noise you are not an 'average' investor by definition.

You want an easy double over the next three years? Buy a mix of Franco Nevada, Eurasian Minerals, Silver Wheaton, Sprott Resources, CNQ, and the Central Fund of Canada.

used to be you could turn it over to a mutual fund guy but that went out the window also.

Hell.. even state and corporate pension funds are getting dinged big time these days.

The restrictions make it difficult for the average mutual fund or pension fund to make much of a way in returns. What is considered 'safe' by the regulators and the industry standards is actually the last thing you want to hold in a portfolio in the times that we live in today. Look no further than the Basel II and Basel III agreements to see a perfect example of what I mean.

I don't worry about contractions with my 5-, 10-, and 20-year financial plans. I short-term ladder my 0-5 year cash-flow needs with "safer" investments and current income/pension earnings.

The market goes up, and the market goes down. It always has, and I assume it always will. If it does not follow this historical pattern in the next ten-year period, I will adjust my plans accordingly. I do worry about 100% losses because you cannot recover from those regardless of how long you hold them.

You are ignoring the way that the Fed is robbing savers and investors of purchasing power. Your biggest danger is a devaluation of the USD that takes most of your investments down 50% of so in real terms. Have you hedged your positions to make sure that such an outcome does not hurt you?

thank you Morg. I admire the way you think... and appreciate you sharing your view.

LOL... He has been thinking that way for years. Yet you have failed to learn from any of his previous postings. It is doubtful that anything has changed on your part. After a few days you will go back and make the same silly arguments that you always have.

From what I can tell the killer was the enactment of the Seventeenth Amendment. It reduced the power of the States and concentrated power in Washington. It did not help that Americans have this stupid idea that the Supreme Court is able to be the final voice on what the Constitution meant. I doubt that was what any of the founders expected to happen

it's all marketing. with a few (and fewer all the time) notable exceptions, the managers are mostly hacks.

they long ago figured out that it's cheaper to just start a zillion funds, throw them at the wall, see what performs, then market the hell out of it before it is exposed as luck not skill than to actually try to consistently make money through acumen and diligence.

the guys who really knew how to make money all went to the hedge fund structure as, if you generate serious returns, it pays you far more and with far fewer regulatory headaches and costs and the ability to makes sensible investments instead of being largely banned from most asset classes and short selling.

i have no idea why any sensible investor would want to run a mutual fund other than making a living by working 10 hours a week and mostly being a closet indexer.

media blackout? seriously? what, the financial press doesn't report bad news about banks? i can see saying they don't understand, but he really veered into tin foil hat territory.

he's also monstrously wrong with that 93 or 97% number he tossed out for cds exposure.

this is especially true of greece. german landerbanks were some of the big writers of CDS's there as were many other continentals. this is going to keep germany and france, who are driving the process firmly in the "it has to be 'voluntary' " camp.

he's also wrong about what's going to determine whether the CDS's trigger. that's all going to come down to greece and how they structure it and the rest of the negotiation. after that, it's all very cut and dry and loss ratios and whether or not a default occurred will be up to greek courts.

they have the not insignificant ability to change the law on their side and they know how the CDS definitions of default work.

sovereign CDS's are going to turn out to be money flushed down the drain. a soverign has too much power to change the rules and too much leverage to force "voluntary" capitulation to ever trigger them. it's ironic that buyers of CDS's were mostly concerned about the risk or a counterparty being unable to pay, when that was never the issue.

after 3 minutes of almost entirely bad data, wild conspiracy claims and illuminati type thinking backed by hysterics about an implausible impending disaster based on flawed numbers, i just had to shut it off.

media blackout? seriously? what, the financial press doesn't report bad news about banks? i can see saying they don't understand, but he really veered into tin foil hat territory.

You may be right. I have had some loud arguments with Sinclair but I would not dismiss him as easily as you have.

The point he makes is valid. How can a 50% haircut not be deemed to be a default? And if if it is not deemed to be a default what are all those hedges purchased by people who were long the bond market really worth? After all, they were supposed to have insurance against such an outcome only to find that the banks that issued the insurance have come to the conclusion that they do not have to pay it.

This seems to be a serious problem as far as I am concerned. It is ignored by the media because it does not understand the long term impact. After all, why would anyone hold risky bonds if the insurance that they took out against default is worthless?

My guess is that many of the institutions that purchased such bonds will be gun shy and that the eventual solution will be outright monetization by the central banks and the primary dealers. That means a big problem for the currencies and nominal gains for stocks, commodities, and even the real estate that Mark has been hyping.

It seems to me that Sinclair is suggesting that we should see some serious inflation in the next 12 months, probably after the election but possibly before then. And I would not discount the problem for the US banks if Greece walks away eventually. After all, they wrote the insurance against the bonds and there is no way that a 70-90% loss can be deemed not to be a default.

I am going to the shareholder meeting on March 1st. Hopefully he will be clearer. While my first instinct is dismissal given the track record he has had over the past decade I would not bet against Sinclair. For the record, the $5K I invested in his company has resulted in me pulling out $45K of cash. (I still retain the original amount of my investment as part of my holdings, mostly so that I can go to the AGM and listen to the presentations.)

The insurance angle. If you buy a bond and hedge it you expect that a 50% payout to be deemed a default. If it isn't why should anyone buy bonds in Greece, Portugal, Spain, etc.? And if it is deemed to be a default how do the banks that wrote all that insurance and dominate the market survive?

One of my pals was suggesting that Jon Corzine has gotten away with his fraud so far because of the fraud carried on by the banks that wrote the insurance that he used to hedge his European bonds. He was wondering what happens to all the other clearing houses and financial institutions that have similar exposure but no way to collect on the default swaps.

"The point he makes is valid. How can a 50% haircut not be deemed to be a default?"

easily.

you are playing in a rigged casino.

don't get me wrong, i am not claiming it is good or right or ethical, but it's what will happen. count on it.

the fine print of a CDS says that voluntary write downs are not considered default and therefore do not trigger the insurance loss provisions.

to my mind, this was a flaw in the original contract structure.

after the way that senior and secured creditors (and CDS holders) got railroaded in GM and chyrsler, i think any sane CDS buyer would have to be incredibly wary of going up against a sovereign.

they just change the rules and dive through a legalistic loophole that, while utterly flouting the spirit of the law, adheres to it strictly in a black letter sense apart from one thing: coercion.

the GM creditors were threatened with extinction if they did not accept the "voluntary deal". i know some personally. they were told that they and all their limited partners would get audited to the limit of the law every year forever if they did not accept the deal.

it was "voluntary" in the same way giving your wallet to a mugger is.

because of the international complexity, the greek deal is not going to be quite as egregious, but there are lots of sticks and maybe a carrot or two that are going to be applied and the rights of "non-official" bond holders are particularly weak and subject to arbitrary modification.

banks and BD's and funds all want to be able to participate in future primary bond auctions across the eu, want to avoid brutal forensic audits, etc.

sufficient pressure will be brought to bear to make the writedown "voluntary" and thus, CDS's will not trigger any more than your home insurance does if you voluntarily break your house up with sledgehammers.

this is a blatant and unethical misuse of governmental coercive power to be sure, but to whom will you complain? the same bully that just took your lunch money?

so, broadly, i think he has really missed the boat on what's going to happen and is engaging is a bunch of misinformed hyperbole and conspiracy theory fueled by bad data and a very poor grasp of how this system works, including the fact that CDS's are on individual bonds, so any payoff would always be in tranches laddered with maturity, so notions of a "cataclysm this tuesday" are impossible even if his notions of the situation were correct.

the dangers of doing business with a sovereign are manifold and i see good reason for outrage here.

i'd be pissed as hell if i owned these cds's. on the other hand, post GM, there is no way i would even consider it if there was a "voluntary" clause, as it had already been shown to be worth nothing when up against a government.

there is a large contingent in the OECD governments that view things like CDS's as "financial weapons of mass destruction".

this is not entirely wrong. 200:1 levered instruments written OTC and not cleared can get very dangerous when they cascade.

unable to figure out how to regulate such things and certainly unable to keep up with innovation that would route around any regulation, such a contingent is pushing for another strategy: make them look unattractive, arbitrary, useless, etc.

by consistently finding ways to make them worthless, they hope to kill the market.

this is a logical (if unethical) way to go about it.

make it clear you will rig the game, and nobody will play.

the fact that it actually serves to reward the riverboat gambler that wrote CDS's and punishes those who tried to be cautious and hedge their exposure is, to their mind, unfortunate, but there you are. (if they even see it that way. they may be aiming at naked buyers of CDS's that they brand speculators).

otc derivatives have become a much, much more complex situation as a result of all this.

the fine print of a CDS says that voluntary write downs are not considered default and therefore do not trigger the insurance loss provisions.

to my mind, this was a flaw in the original contract structure.

But that is the problem. When a leveraged entity is forced to take a 50% haircut and cannot use the default swaps to cover the losses it goes out of business.

We are talking about huge bets here in which the only way that bankruptcy can be avoided is by not taking a voluntary haircut. No matter which road is taken you have bankruptcies or bailouts.

after the way that senior and secured creditors (and CDS holders) got railroaded in GM and chyrsler, i think any sane CDS buyer would have to be incredibly wary of going up against a sovereign.

That is my point. If bond holders get screwed why would anyone buy sovereign debt when the old bonds need to be rolled over?

You see the problem that Sinclair is pointing to? No matter which thread you choose to take there is always insolvency for someone and in all cases the intermediate step is increased liquidity and currency devaluation.

so, broadly, i think he has really missed the boat on what's going to happen and is engaging is a bunch of misinformed hyperbole and conspiracy theory fueled by bad data and a very poor grasp of how this system works, including the fact that CDS's are on individual bonds, so any payoff would always be in tranches laddered with maturity, so notions of a "cataclysm this tuesday" are impossible even if his notions of the situation were correct.

John Embry once pointed out that if I did not want to go nuts I had to forget the hyperbole and the method of presentation. The important parts were the information and the logic.

If we follow Sinclair's logic he is saying that there is no way that the bonds will be deemed to be in default by the very institutions that have to pay out in case of default. But that leads to a serious problems for sellers of debt. Without the ability to buy insurance contracts that will pay out there is little incentive for anyone other than the big banks who get access to free money to buy sovereign debt.

If you agree so far you have to agree that the monetization of sovereign debt by the central banks and primary dealers will eventually lead to huge inflationary pressures that should be seen in rising equity prices, higher commodity prices, and higher real asset prices. If you don't you are betting that speculators who used to hedge by using swaps will continue to keep taking what they have to consider higher risks without the safety net of insurance. That is not logical.

But as I wrote above, without the ability to hedge bets why would anyone take the risk of lending money to governments on the verge of bankruptcy? What happens to the muni market if buyers can't depend on swaps to save them if things go badly?

make it clear you will rig the game, and nobody will play.

the fact that it actually serves to reward the riverboat gambler that wrote CDS's and punishes those who tried to be cautious and hedge their exposure is, to their mind, unfortunate, but there you are. (if they even see it that way. they may be aiming at naked buyers of CDS's that they brand speculators).

But what is lost in this argument is that the game is the bond market itself. To end it just as the demand for sovereign borrowing is at historical highs seems like the type of risk that the governments that need the money do not wish to take. I can just see farmers being told that they have to lose the money that they had with MF Global because JPM and GS would not pay out on the Greek bond defaults. If you think that the OWS movement is angry now imagine what happens when they have more ammo and more support from mainstream people who are finally pissed off from being treated like sheep to be fleeced.

otc derivatives have become a much, much more complex situation as a result of all this.

i don't want to go anywhere near it if a government is involved.

Which was what Sinclair was saying. If you and others don't go there the treasury market will rely on money printing and primary dealer purchases. How does that way not lead to hyperinflation?

"But that is the problem. When a leveraged entity is forced to take a 50% haircut and cannot use the default swaps to cover the losses it goes out of business.

We are talking about huge bets here in which the only way that bankruptcy can be avoided is by not taking a voluntary haircut. No matter which road is taken you have bankruptcies or bailouts."

this is much too extreme a scenario.

much of it has already happened. the big euro banks holding greek debt have already taken 40-50% write offs. that 50% you cite is from face, not market price. you're treating a mark to market instrument as though it has not been priced all along. only if greek bonds were carried at par (and no one is doing that) would he be correct.

"You see the problem that Sinclair is pointing to? No matter which thread you choose to take there is always insolvency for someone and in all cases the intermediate step is increased liquidity and currency devaluation."

again, see above. sinclair is totally missing the boat. the write downs have mostly already occurred.

he is confusing a 50% write down from face with a 50% write down from current market price. this is a shockingly elementary mistake for someone who purports to be qualified to offer financial advice to make.

there are lots of ways to hedge debt exposure. sure, the idea that rates on sov debt will rise as views on CDS's value drop is valid, but again, a lot of it has already happened.

sinclair is taking the outlandishly naive view that this is a surprise and not priced in when, in fact he's six months behind the market. absolutely everyone knows what's going on and has for ages. this discussion was taking place at the beginning of last year all over the street. no one is surprised.

sinclair is the classic guy thinking he should sell the news while totally unaware that everyone else has already sold the rumor.

"But what is lost in this argument is that the game is the bond market itself. To end it just as the demand for sovereign borrowing is at historical highs seems like the type of risk that the governments that need the money do not wish to take."

again, much of this is priced in already. don't forget, there are huge bond funds that have to be 100% invested. they need to buy something. it's going to be sov debt. there is nothing else big enough. the EU will go to "eurobonds" or explicit guarantees or whatever. they will find some way to link ability to pay to ability to print.

inflation is the big risk here. i fear money is going to get awfully loose all over and real rates will be deeply negative.

they will do their best to hide the inflation by cooking CPI (and note they are looking at ways to make it read even lower as we speak) but as i think you and i agree, that's not going to change the real world much.

sinclair does have some points about inflation, but his ideas about an impending catastrophe are really overblown.

if he wants to be taken seriously, he needs to learn how mark to market works, get caught up with the markets he's talking about, and stop talking rubbish about the world ending on tuesday in a breathless tirade that "there isn't even time to edit" and "media blackouts".

the guy has some points, but cannot seem to tell hysterical cookery from reality, so it all gets blended together.

he's said nothing the street hasn't know for ages and packaged it with a bunch of really fundamental misunderstandings and hysteria.

hey, if you have gained valuable insight from him, great. personally, i find him impossible to listen to. there are lots of sources of good info without the tin foil hat stuff and the bizarre inability to understand mark to market.

much of it has already happened. the big euro banks holding greek debt have already taken 40-50% write offs. that 50% you cite is from face, not market price. you're treating a mark to market instrument as though it has not been priced all along. only if greek bonds were carried at par (and no one is doing that) would he be correct.

Has it already occurred? That is the problem; there is no evidence that all of the players who are exposed have written down their losses. In fact, given what we know about the leverage used I do not see how the banks could claim to be solvent if they wrote down the bonds.

Keep in mind that Basel III was telling banks that if they wanted to commit little to reserves they better hold 'safe' sovereign debt. This is why Coxe and Sinclair have pointed out the 'good' banks as being in such terrible shape. They bought sovereigns, set aside very little in reserve for losses, and are now looking at insolvency if proper accounting were to be used.

he is confusing a 50% write down from face with a 50% write down from current market price. this is a shockingly elementary mistake for someone who purports to be qualified to offer financial advice to make.

there are lots of ways to hedge debt exposure. sure, the idea that rates on sov debt will rise as views on CDS's value drop is valid, but again, a lot of it has already happened.

I don't think so. And the banks are not the only players in this space. Many hedge funds bought the bonds and the swaps as insurance. They don't care about default if they believe that the swaps cover them. But if they were to finally discover that the swaps are worthless you could see a major run as they tried to dump sovereign debt in a panic to recover as much as they could. We have already seen what happens under such circumstances.

Keep in mind that Sinclair points out that no matter what the haircut the banks will never pay out the insurance. The problem is not the bankruptcy of the speculators who bet wrong but what the process does to the market for sovereign bonds.

How do you invest if you can't hedge effectively?

sinclair is taking the outlandishly naive view that this is a surprise and not priced in when, in fact he's six months behind the market. absolutely everyone knows what's going on and has for ages. this discussion was taking place at the beginning of last year all over the street. no one is surprised.

sinclair is the classic guy thinking he should sell the news while totally unaware that everyone else has already sold the rumor.

I do not believe that you are giving the man enough credit. He is an old hand at this and knows exactly how the markets work. As a practitioner he knows far more than the academics who built the fancy models that don't work all that well and has been in the business long enough to have seem most tricks.

Keep in mind that he was quite accurate when he called the gold top in 1980 and was right again near the bottom in the late 1990s. While I have had my disagreements with him on a few issues I think that he has been excellent at figuring out the primary trends and am grateful about the nice profits that he has made for me along the way.

sinclair does have some points about inflation, but his ideas about an impending catastrophe are really overblown.

if he wants to be taken seriously, he needs to learn how mark to market works, get caught up with the markets he's talking about, and stop talking rubbish about the world ending on tuesday in a breathless tirade that "there isn't even time to edit" and "media blackouts".

You did not listen to the commentary. He predicted that because taking the just way and declaring a default was not in the cards (your fixed market argument) the likely route would be a full press using the printing presses. He expected a boom in prices, not a catastrophe. He said that if the central banks resorted to flooding the system, as they must, prices have to start to go up and will go up sharply.

And you keep forgetting that the bond funds are already all in and that given the low yields few people will be looking to buy two treasuries yielding 0.25% or T-bills at 0.05%. Prices are set at the margin and the usual suspects are no longer playing at the margin. They are looking to shed their risks, not add to them by buying sovereigns issued by governments that cannot meet their obligations.

Imagine what happens if the idiots at the Pentagon actually do what they want and go after Iran. What happens to oil prices if a stray missile hits a Saudi oil facility or an LNG depot? How many countries will defy the US embargo and move to sell their goods and services in their local currencies or a basket of currencies? And what happens to the USD as a reserve currency if high inflation rates are created by the money printing by the Fed and by a move to trade oil using currencies other than the USD?

"here is no evidence that all of the players who are exposed have written down their losses"

yes, there is. much of it was publicly announced (like BNP) or would have been marked to market (as in the US) anyway.

these bonds trade v. they have prices. what, you thing goldman is carrying them at par on their sheets? that would be illegal. if a bond is trading at .55, you do not carry it at par if there is a market. this is not some tiny OTC product where there is no market and you can play games. it's a govvie.

you are making all sorts of outlandish assumptions that hedge funds are incredibly stupid. this story about CDS's not being valid is months and months old. everyone knows this. sinclair is 6 months to a year off the market.

he's taking old, old news and trying to make it a "new" crisis.

lots of these hedge funds bought at .45 and selling at .55 will be a profit. the losses were already taken at many big banks.

seriously v, call a bond desk. ask around. you are being terribly misinformed here. sinclair has no idea what he's talking about.

"How do you invest if you can't hedge effectively?"

this question doesn't make any sense. you invest with directional exposure. i own tons of things that cannot be hedged. you act like there was no govvie market before CDS's. they are a very new product. bonds got bought just fine in the last 200 years before CDS's. countries defaulted. they got punished, life went on.

what is it that you think is new here?

"They are looking to shed their risks, not add to them by buying sovereigns issued by governments that cannot meet their obligations. "

wrong. they are upping leverage to to get better absolute returns from low yield bonds.

and he did predict catastrophe.

listen to the first 3 minutes again.

he breathlessly warns of a collapse on tuesday and news so urgent that there was not even time to edit this interview.

the guy is a hysteric and the banking collapse he describes is totally imaginary.

why lead with that if it's not your message?

i think you are giving this commodities permabull and conspiracy theorist too much credit.

he'll get mauled when the cycle shifts. guys like him are always yelling "gold $10,000" right at the top.

yes, there is. much of it was publicly announced (like BNP) or would have been marked to market (as in the US) anyway.

I just heard commentary on CNBC that one of the problems with the European banks was the lack of capital to offset expected losses from their bond holdings. And I am sorry but I do not buy the story that the banks have taken the necessary steps to write down their exposure. I still see far too much leverage and a lot of wishful thinking.

these bonds trade v. they have prices. what, you thing goldman is carrying them at par on their sheets? that would be illegal. if a bond is trading at .55, you do not carry it at par if there is a market. this is not some tiny OTC product where there is no market and you can play games. it's a govvie.

Frankly, after talking and listening to the RBC people, Eric Sprott, and a number of other people in the business I have no idea what the banks are carrying on their books and how they are accounting for exposure.

you are making all sorts of outlandish assumptions that hedge funds are incredibly stupid. this story about CDS's not being valid is months and months old. everyone knows this. sinclair is 6 months to a year off the market.

he's taking old, old news and trying to make it a "new" crisis.

lots of these hedge funds bought at .45 and selling at .55 will be a profit. the losses were already taken at many big banks.

I think that the weakness in your argument is the assumption that the losses have already been taken and disclosed. I don't believe that is the case. Clearly neither does Sinclair. He seems to be saying that we will see an attempted replay of the early 1970s. The ECB will lend money to the European banks at zero interest. The banks will take the money and buy European sovereign debt that yields a hefty return. The banks will make out like bandits while the Euro will be under pressure from the increased liquidity. The Fed will do the same in the US because it does not want to see the USD go higher and because the US banks are not much better. Other central banks and governments will do pretty much the same thing. They will increase liquidity to force prices higher and to bail out debtors. The problem is that all those pensioners and savers who depend on purchasing power to stay fairly constant will be sacrificed. Frankly, I don't see how we avoid hyperinflation.

this question doesn't make any sense. you invest with directional exposure. i own tons of things that cannot be hedged. you act like there was no govvie market before CDS's. they are a very new product. bonds got bought just fine in the last 200 years before CDS's. countries defaulted. they got punished, life went on.

what is it that you think is new here?

A functioning CDS market is required for the bond market to hold up. Without it we move to direct monetization and see the banks buy government bonds with newly printed money borrowed from the central banks. Can we say Wiemar Republic?

But I am more concerned about what I have been hearing in the financial media as I drive my kids and wife around. They are talking about a deal that could lead to trouble.

Let us say that the Greek passes a law that compels all bond holders to take a haircut. That would trigger the payouts on the credit-default swaps written by the US banks because there would be no way to convince any court that the settlement was voluntary. That would transfer much of the risk from the European banks to the US banks that wrote the premiums.

Sinclair is arguing, as you are, that this will not happen. I am not so sure.

wrong. they are upping leverage to to get better absolute returns from low yield bonds.

and he did predict catastrophe.

listen to the first 3 minutes again.

he breathlessly warns of a collapse on tuesday and news so urgent that there was not even time to edit this interview.

the guy is a hysteric and the banking collapse he describes is totally imaginary.

why lead with that if it's not your message?

Most of my disagreements with Sinclair have come about because he chose some of his words badly. What you heard is not his message. He said that if that happens the US banks would be in serious trouble therefore it won't happen.

But as I wrote above, any legislation that compels a settlement could very well trigger the event that he said would be catastrophic but unlikely to happen.

I would be happy to read how a compulsion to accept a 50-75% loss is not considered a default in any court of law or if it is how such a default would not cause a major problem in the sovereign debt market.

i think you are giving this commodities permabull and conspiracy theorist too much credit.

he'll get mauled when the cycle shifts. guys like him are always yelling "gold $10,000" right at the top.

Actually, he got out of gold before the top in 1980 and argued that it would be in a 15 year bear market. He got back into the metals in the late 1990s and has been positive since. My problem with him is not about the secular trend. It is because he encourages far too much trading even though he knows that most people are not capable of controlling their emotions.